How Zynga Makes Money

Despite a worrisome June quarter, Zynga is by any measure an amazingly successful business. It is now consistently profitable on nearly a billion dollars in revenue, having been founded only in 2007.

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But how does Zynga make money, exactly?

Two ways:

From the sale of so-called virtual goods, which are used as currency within Zynga's online games and are items that help the player in the game, and

From advertising, both in and around its games.

Right now advertising is a very small part of Zynga's business. But it's growing fast (see chart).

And now let's take a look at both of these revenue streams in detail...

Advertising

There are three types of ads you can find in a social game:

Banner ads,

Video ads and

Product placement.

To understand the advertising opportunity in social games, we spoke to Julie Schumaker, general manager of social games company RockYou.

BANNER ADS are simple, IAB standard ads that show up below or above a game (see screenshot example below).

Business Insider Research Illustration

Because these are simple banner ads inside social networks where ad response is low, they tend to be priced at bottom-of-the-barrel CPMs of around $2, we hear.

However, because social games generate so many pageviews, they are the biggest part of advertising revenue for the social gaming industry.

VIDEO ADS are pretty self-explanatory. They are the ad format with the most revenue per view. Video ads tend to be higher-priced elsewhere on the internet as well, and as in other venues, video ads are priced either by CPMs ($35+ CPM in social games, we hear) or cost per completed view. According to studies we've heard about, video ads are the ads with the highest brand recall and so should be a good deal for advertisers despite the relatively high price.

Video ads are shown either in in-game interstitials (e.g. when the game is loading a new screen, you might see an ad during that) or through incentive-based advertising, meaning that you will get either an in-game reward or Facebook Credits (i.e., money) for watching an ad.

The final, nascent and potentially most interesting category is PRODUCT PLACEMENT. A brand or product will be injected in a game in some way.

McDonald's product placement inside FarmVilleViralblog
Because of the myriad ways in which product placement can be accomplished in any media, and because the category is nascent, this category isn't standardized at all, but some examples include branded in-game goods (see screenshot example at right) or even in-game quests (e.g. in a game where you run a restaurant, you might be asked to collect ingredients to make a Starbucks Frappuccino, and receive in-game rewards for doing so).

Because these product placement deals are non-standard, they are largely charged with a production fee, which we hear can be $350K-$750K depending on the type of placement and the popularity of the game.

Virtual Goods

A lot of ink has been spilled on Zynga's business model based on the sale of "virtual goods" and whether it can be sustainable.

First of all, what's a "virtual good"?

Within the context of social games, a virtual good is some form of in-game item or currency that players pay for directly or indirectly. (We'll explain what that means in detail.)

Is it sustainable? Absolutely yes.

One of Zynga's core business metrics is average bookings per user (ABPU), which Zynga defines as average daily virtual goods sales per average daily active user (bookings is the total amount of revenue Zynga gets in a period, which is different from GAAP revenue because Zynga recognizes revenue over time).

The vast majority of ABPU is virtual goods revenue, which shows no sign of flagging. It's also not growing, however, which is a problem for a growth company:

Business Insider Research

This means that Zynga players have no problem buying virtual goods for the company. They might buy less sometimes, just like any product might not sell well all of the time, but there is no indication in the data that the business model of selling virtual goods itself is unsustainable.

Okay, so we know virtual goods work as a revenue generator, but how does Zynga get players to buy them?

Zynga games are always free to play. You might spend money in the game, however, for two main reasons:

To progress faster;

To improve your accomplishments in the game.

Zynga games purposefully involve a lot of waiting and even measured amounts of tedium.

This is in part because of the game experience: people play Zynga games during breaks in the day, instead of in long sessions like traditional games. Having to wait a few hours for, say, crops in a farm to grow, fits in well with the life of a gamer who might visit the game two or three times during the course of a day.

But the built-in delay in the games is also designed to make people impatient. If you want to keep playing, you can either wait a few hours for your crops to grow or your energy levels to replenish—or you can pay to keep playing now.

Another motive to pay is simply to get better in-game items. Since games on Zynga are social and you play with your friends, there is an element of direct or indirect competition. And so you might pay to trick out your farm and make it much nicer than your friends'.

You buy virtual goods on Zynga via Facebook Credits; once Facebook has your credit card details, the entire billing process is very smooth and handled in few clicks. So it is very easy to impulse-buy a few dollars' worth of in-game currency to get ahead in the game (see screenshot above).

What's more, you can earn virtual goods and in-game currency..

Zynga regularly partners with brands to let people earn virtual goods through actions other than buying them directly, either by buying indirectly or doing actions that brands are prepared to pay for like signing up for a newsletter (see screenshot below).

Business Insider Research illustration

This is useful both because it helps get money from people who have a problem with the psychological hurdle of spending money on virtual goods, and also because it helps get cash from younger players who might not have a credit card.

In summary, Zynga's revenue engine features two products:

Virtual goods, which accounts for the vast majority of the revenue, and

Advertising, which is actually growing faster

Virtual goods are a sustainable, strong business model, with very high profit margins (they don't cost Zynga much to make).

People pay for virtual goods because they're a form of entertainment, as strange as it might seem to some people. And Zynga has complemented the basic model of charging for virtual goods with advertising and other forms of indirect purchase of virtual goods. It's an innovative, diversified and resilient revenue model.

If Zynga is to remain a "growth company," therefore, it is going to have to figure out how to keep growing its user base and increasing the amount of virtual goods that its users buy.

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